Dell's Future: 3 Wild Cards CIOs Should Understand

When Dell's board of directors recently approved a $24 billion bid led by CEO and founder Michael Dell and private equity firm Silver Lake Partners to take the company private, it marked the largest leveraged buyout since the financial crisis. Another twist to the deal is Microsoft, which will provide $2 billion to support the "long-term success of the PC ecosystem."

While Dell remains a major hardware provider -- 70% of its revenue still comes from PCs and related software and peripherals -- the company has taken significant steps over the past few years to transform itself from a PC and server vendor into an end-to-end enterprise services provider. Since 2007, Dell has acquired 27 companies in pursuit of this strategy, including application modernization services firms Clerity Solutions and Make Technologies in 2012, managed security services firm SecureWorks in 2011, and Perot Systems in 2009, resulting in a 19.2% year-over-year growth rate in its services and software revenue over the same period.

Still, while it's received positive reviews for its IT outsourcing (ITO) capabilities from research firms including Gartner and Forrester, Dell has struggled to be perceived as a top-tier ITO provider outside of niche areas like healthcare and government. Even in the managed desktop arena, where Dell should maintain a value proposition rivaled only by HP, it has been unable to coordinate its services and OEM businesses to meaningfully compete with the likes of IBM, TCS and Wipro.

For CIOs considering buying in to Dell's ITO vision, the transaction (assuming it's approved by shareholders) will have ramifications in three main areas:

-- The benefits and risks of going private. On the positive side, now that every dollar invested doesn't need to move the near-term earnings needle, Dell will be able to make longer-term investments to grow and enhance its services business without sweating market scrutiny and quarterly earnings pressures. The company can also focus management attention and resources on unifying its string of acquisitions into an integrated software, hardware, and services platform. As Dell's CFO Brian Gladden recently commented, "Without having the scrutiny that is associated with a publicly traded stock, we can make the necessary investment and stick to plan, [and] in some cases be more aggressive than we can today."

Conversely, the limited buyout will put serious pressure on the company's balance sheet. That could inhibit its ability to invest to expand and improve its ITO capabilities -- with some $17 billion of new debt, Dell will be obliged to satisfy its creditors first and ITO customers second. Such uncertainly is anathema to companies outsourcing their IT infrastructures. When the foundation of the business is on the line, CIOs want stable providers that present little risk of unexpected pivots that might force them to scramble for alternatives. Yet Dell's new set of financial pressures could result in spin-outs of business lines deemed to be "non-core" to the future, though it is difficult to tell at this point whether legacy hardware businesses or newer ITO businesses would be targeted for divesture.

-- The Microsoft investment and its potential impact on future service offerings. Yes, Microsoft's $2 billion did not buy it board seats or voting rights. But that level of investment is generally not without some strings attached. While Microsoft can bring innovation, improved software and cloud capabilities and resources and knowledge to optimize Dell's services offerings -- especially those that leverage Microsoft products -- Dell may find itself under pressure to index more heavily to Microsoft offerings. And that may hinder Dell being perceived as technology-agnostic provider, a la Accenture, and frustrate efforts to gain traction in the ITO space.

-- Michael Dell himself. He is certainly putting his proverbial money where his mouth is by contributing his entire 17% ownership interest as part of the privatization bid, along with some $700 million from one of his investment companies. Dell's vision and energy drove his namesake company from a $1,000 startup operating out of a dorm room to one of the largest PC suppliers in the world, and having a substantial part of his personal fortune on the line makes it likely that energy will be out in full force. However, there's also a real possibility that Dell's actions are motivated more by considerations of his legacy or a determination to double down on the OEM business than by a burning desire to build a legitimate Tier 1 enterprise-class ITO provider.

Dell's buyout could end up benefitting customers by bringing a more strategic, enterprise-level focus. But it also raises concerns -- we can't know with any certainty how a privately held Dell will fare in a competitive ITO market, and its true commitment to the ITO business will likely not be fully understood for months to come. For now, CIOs contemplating a relationship with Dell should:

-- Think twice about a long-term relationship. Factor in uncertainty when defining term commitments. CIOs contemplating large-scale projects should be especially sensitive to the risk of unforeseen changes of strategic direction (on Dell's part) and the effect on service delivery. Contract term lengths (original and renewal options alike) should be of appropriate duration to allow a timely exit should the relationship not meet expectations.

-- Question its dedication to ITO. Depending on cash flow, Dell may be forced to concentrate on meeting its outstanding debt obligations vs. investing its ITO business, corresponding innovation, complementary acquisitions and new corporate customer relationships. Insist on multi-level formal governance provisions in all agreements, as well as upfront meetings with senior executives to gain comfort in Dell's commitment to the ITO space in general, and to you as a customer in particular.

-- Maximize flexibility while minimizing downside risk. Place a premium on low/no service commitments, low-cost terminations for convenience, step-in rights, technology currency and innovation/productivity requirements. At the same time, uncertainty over future direction and the comparative opaqueness of private company financials place a heightened importance on audit rights, disengagement assistance and divestiture support and termination for change of control.

As presently constituted, the proposed LBO will utilize Dell's current cash flow that previously was devoted to acquisitions and buying back stock to service the new (and higher) level of debt. Customers should therefore not be worried about whether Dell will be able to meet its commitments to them.

In 1997 Microsoft invested $150M in Apple Computer and committed to a better Mac version of the Microsoft Office Suite. Although the investment was small relative to the recent $2B investment in Dell the deal helped Steve Jobs revitalise the then waning fortunes of Apple. Michael Dell can see the writing on the wall - the PC market is in rapid decline and server computing is moving to the Cloud where the big PaaS and IaaS utilities like Amazon, Microsoft and Verizon can buy servers at 70-80% discounts. Microsoft sees its future in the Cloud with Azure and mobile devices with Surface and smart phones and that's why teaming with Dell and Nokia makes perfect sense. Michael Dell has probably already done a deal to manufacture and sell Microsoft Surface under contract and supply Microsoft with hardware for its massive data centers around the world.

This is good advice from Pace Harmon's David Rutchik. Dell has gained valuable experience in next generation data center architecture by providing equipment for Microsoft's Azure data centers and those of various search engines and online service providers. Can its consultants convert that know-how into modern architectures -- virtualized servers, storage and networking -- that fit medium-sized enterprises, which are a natural constituency for Dell? Maybe they can. A possible red flag: "We'll save you money by replacing your VMware with Windows Server and Hyper-V." Charlie Babcock, InformationWeek

The author writes: "However, there's also a real possibility that Dell's actions are motivated more by considerations of his legacy or a determination to double down on the OEM business than by a burning desire to build a legitimate Tier 1 enterprise-class ITO provider. "

The overwhelming reaction in my Twitter stream, and among IT people I know, is that they are rooting for a dramatic next act from Michael Dell. I'm not sure he knows what his legacy will be, but I would bet it is more colorful than battling IBM on services. Mobile, anyone?